Fluctuating consumer demand drives the debt market. It is fully aware that money goes out faster than it comes in for a small business.

Whether you are looking to high net worth angels, traditional banking partners or contributing individuals, the terms of return determine your cost.

Small business continues to change the economic landscape of business as a major contributor to the U.S. economy, employing approximately 1/2 of the U.S. workforce. This is why private business remains a lifeline to the economy.

Despite, this fact small business owners still struggle with the cost or availability of traditional funding and seek out alternative sources. Alternative lenders have flourished as businesses collaborate to convert assets into funding capital. Strategies secure collateral such as a verifiable invoice as loan capital. Others charge higher interest rates or prefer equity shares.

As the process of securing money for your small business can be a lengthy, detailed process, it’s important to know the true cost before venturing down any specific avenue.

Bank Loans

Growth is the main reason small businesses looks to a traditional loan for funding. You need to understand the terms of interest you will pay for borrowing the money. Here are two forms of interest used in business lending.

Simple interest is the standard when borrowing from lenders. When you borrow $10,000 over three years at ten percent, you pay back $11616.12.

Compound interest recalculates the loan’s balance at specific intervals but most often monthly. Though you can normally get a better interest rate, if you use the same numbers from above the difference becomes significant.

Since you’re paying interest on the loan’s interest, the same 10% loan compound monthly will cost you a total of $13,500 when all is said and done.

Crowdfunding

Crowdfunding has been the source of seed money for many new ventures raising capital through contributions. This source involves individual contributions without offering collateral or equity shares.

The plus side to Crowdfunding – the financial debt is low. It relies on third party fee structures with management services for the hosted campaign development and credit card processing. The costs range from eight to ten percent of the contributions. If you host yourself, expect out-of- pocket expenses.

Though the funds technically cost you no money, you’ll need to consider the 8-10% fees into the total you are asking for, or risk a less-than-desired total.

You also need to consider the cost of encouraging donations. Offering small gifts for specific donation levels is common, effective and often encouraged by the host, but these “gifts” also need to be factored into the cost of obtaining your funds or the total you’re asking for.

Lastly, when attempting to crowdfund capital, you must also consider the high rate of failure. If your efforts don’t stir the crowd to donate, you’ve waste a bunch of time and effort for nothing. It’s best to choose crowdfunding if you have at least one of the following:

  • A truly unique business or business model that others would find interesting or would otherwise motivate donors to support.
  • Genuinely valuable gifts to give away to donors, be it t-shirts and other merchandise or your company’s services.
  • A strong charitable element to your need.

 

Capital Angels

Advanced technology and start-ups have boosted the interest of angel investors. Like the other methods of funding, this is a business forum configured on financial risks and costs. Depending upon the risk and the perceived level of involvement necessary to protect their investment. Angel investors often require very high rates of return.  Though the individual offer will vary greatly depending upon your skill in selling the concept as well the investor’s perceived risk, it is not unusual to see 25-40% annual expected return rates for an angel’s investment. There are three ways for receiving capital from an investment angel.

  • Debt through lending – Interest rates are based on the business risk.
  • Investment with shared equity – Sell or exchange a portion of the equity with buy-out options.
  • Combination of both – Interest rates and equity percentages vary.

Invoice Factoring

With Invoice Factoring, the small business owner creates cash flow by selling their invoices at a discounted rate.

Most business owners find this form of borrowing effective for immediate cash advances or short-term loans. The invoice total determines the advance-funding amount. The factor payback is usually set at 30, 60 or 90 days. Generally, a factoring company will advance 60 to 80 percent of the invoice.

Based on a 60 percent advance with a factor rate of ten percent for a $1,000 invoice, you get $600 and pay $100 in factor fees. The remaining $300 covers any late fees accumulate, releasing the remainder when the invoice is paid-in-full.

Conclusion

Keep in mind, the higher the risk the higher the interest rate. Before you borrow funds, ask yourself these four questions.

  • How much can you borrow?
  • What is the interest rate?
  • What are the terms to repay?
  • What are the fees?

 

Knowing how much money and/or effort your needed funds will cost you in the long run, will help you make a sound lending decision now.

 

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Please keep in mind that the Disorderly Ducks of Woyster Media are NOT accountants or tax professionals by any stretch of the imagination. We want to help others by passing along this free information, but your situation may be different from ours. You’d be freakin’ NUTS to take action on ANYthing we say on the subject without first checking with your accountant or tax professional!